Final answer:
In the basic model with an AD and LRAS curve, if spending growth is 7% and the Solow growth rate rises from 0% to 3%, inflation will decrease because the economy's capacity to produce goods and services is expanding, which can accommodate higher levels of spending without leading to increased inflation.
Step-by-step explanation:
In a basic model with an Aggregate Demand (AD) and Long-Run Aggregate Supply (LRAS) curve, if spending growth is 7% and the Solow growth rate increases from 0% to 3%, inflation will decrease. This is because the Solow growth rate reflects the rate of increase in the economy's productive capacity. When this growth rate rises, it implies that the economy can produce more goods and services without increasing prices. In the neoclassical model, the LRAS curve is vertical, indicating that in the long run, real GDP is determined by the economy's productive capacity, not by the level of aggregate demand. If the Solow growth rate, representing potential growth, increases, it means the economy's capacity to produce goods and services is expanding, which can accommodate higher levels of spending (aggregate demand) without leading to higher inflation. Therefore, if spending growth (aggregate demand growth) was previously causing inflationary pressure in the economy, an increase in the Solow growth rate would help to decrease those pressures by allowing for real economic growth without an accompanying increase in the price level.